Walking along the assembly line at either of Geely's two Zhejiang plants you wouldn't think international carmakers had anything to be worried about. Workers scurrying about with welders and vice-grips evoke a scene from a 1950s Ford commercial rather than the exporting threat to international carmakers the Chinese company has been depicted to be.

Geely swears the plants it's building in Gansu and Hohhot will be automated. But it needn't protest backwardness. Even if its cars aren't built by robots, they're built cheap and they're what the bulk of Chinese car buyers want: a half-decent-looking set of wheels that goes from point A to point B without being too demanding at petrol stations along the way. Geely's 1.6-litre Ziyoujian sells at RMB70,000. That's quite a bit less expensive than some of the competition. The 1.6-litre, 16-valve engine Peugeot 206 hatchback, made by PSA Peugeot Citroen's venture with Dongfeng Motor Corp, retails at an average RMB100,000.

Geely has another reason to be cheerful about its prospects when no less a figure than Premier Wen Jiabao called on his government last summer to strip restrictions on cars with smaller engines that consume less fuel and emit less fumes.

Geely built a reputation, after all, on reliable 1.0- and 1.3-litre cars and is working on a hybrid model through its subsidiary, Maple. Both of those answer to Wen's calls for efficient oil consumption and cleaner air pollution. No sooner had the Premier spoken than the policy-making National Development and Reform Commission (NDRC) came up with solid suggestions, quickly approved, to cancel restrictions on low-emission, economical cars. The order to go green may take a while to per colate in the provinces, but Beijing wants more investment in low-emission, oil-saving cars, including research on engines, according to a circular from the State Council. The circular also promised a linkage between tax rates and engine size. Rising oil prices and a government aim of tripling GDP while only doubling energy consumption by 2020 makes compact cars the way to go. The State Council's missive, when enforced, will be good news for makers of smaller cars, like Geely and Chery. Beijing has long banned cars running on 1-litre engines from the city's main thoroughfares. "They were seen as slower, less safe, more polluting and less attractive for a city's image," says Jia Xinguang, an analyst with the China National Automotive Industry Consulting & Developing Co. But small autos are still barred from the streets of more than 80 cities, adds Jia. In the first nine months of 2005, cars below 1.6-litre emission accounted for 64.17 percent of all cars on China's roads. Sales of cars below 1.0-litre emission rose by 93.69 percent year-on-year to 248,000. That figure suggests China's vehicles are already small by world standards: the Chevrolet Aveo, one of the smallest cars sold in the US, by comparison, runs on a 1.6-litre engine. Still, China has no intention of nudging fuel-heavy, luxury cars off the road, says Dominik Declercq, China representative of the European Automotive Manufacturers Association (ACEA). "Yes, the government is increasingly taking measures to encourage consumers to buy smaller and more fuel-efficient cars. But small cars can consume relatively little fuel yet can have high CO2 emissions.

Luxury cars are often cleaner with the fuel they consume. Driving a luxury car need not be environmentally irresponsible. Anyway, the tiny proportion of luxury cars in the total number of vehicles in use makes not much of a difference when it comes to saving energy."

Not hurting yet

While sales for Geely and Chery are trending up, sales of luxury cars are rising, too. The preferred marque of China's officialdom, Audi, is expecting sales in China to double, reaching 100,000 by 2009. Market leader in luxury cars here since its early decision to manufacture locally, Audi sells its A8 as an import, while other models are made at parent company Volkswagen's venture with First Automotive Works Corp (FAW), China's leading automaker by output. But sales for later arrivals BMW and Mercedes-Benz are growing even faster. BMW, which started to make its 3 and 5 Series sedans in China in 2003 in a JV arrangement with China Brilliance Auto, sold 23,600 cars in China in 2005, nearly two-thirds of which were produced by in China. Sales were up 52 percent from the previous year. Sales of Mercedes climbed 22 percent during the first three quarters of 2005 to 11,000 cars. Mercedes will start to make the E- and C-Class sedans next month at its parent DaimlerChrysler's venture with Beijing Automotive Industry Corp. As further evidence of China's expensive tastes in cars, Swedish luxury brand Volvo, owned by Ford, is preparing a production line in Chongqing. This, despite a slow down in auto sales over the past two years. The government-led cut-off of credit to carmakers followed the heady days of 2003, when Chinese carmakers reported year-on-year sales growth of 34.21 percent. Growth slowed to 15 percent in 2004, and to 12 percent over the first 11 months of last year. That's still a red-hot market compared to Europe and the US. And even though it's the world's third-largest auto market (some Chinese statistical bodies claim it's the second-largest), only eight in every 1,000 Chinese own a car, compared with 900 out of 1,000 Americans.China's catch-up rate is where the sales potential for cars of all sizes lies. The number of private cars on China's roads is expected to reach 17 million by the end of 2005, according to data from China's National Bureau of Statistics. Vehicle sales are expected to reach 6.4 million units in 2006, up 13 percent from 2005, according to the China Association of Automobile Manufacturers (CAAM). The demand is coming largely from second- and third-tier cities, says Xu Changming, an auto industry analyst with the State Information Centre. "Wealthy Chinese consumers will continue to buy flashy cars, but the increasing number of ordinary middle-class consumers want a reasonably priced means of transport."

Carmakers like Geely have done well providing wheels to the upwardly mobile of China's hinterlands. Others are following suit; domestic vehicle sales are estimated to surge as high as 9 million units by 2010, according to CAAM.

Export or die?

This means China will soon have the capacity to build 8 million cars a year, but it already produces 2 million vehicles more than it needs, points out Xu Changming. Extra cars could mean even lower prices and profits for China carmakers - or exports. China's auto exports climbed by more than 120 percent last year to overtake annual imports for the first time. But since the country still exported only 170,000 vehicles in 2005, there's plenty of room for growth. More worrying for international carmakers, China's exports, which have hitherto been largely confined to trucks, have begun to include more sedans and low-priced small cars. Shipments of sedans climbed fastest in 2005, to 30,000 - a jump of 233 percent over 2004, according to CAAM statistics.Chinese automakers have improved standards to competitive levels thanks to the technological expertise gained through joint venture partnerships.

Chery and Geely are obvious contenders in the international small car market, but there are no local competitors in the luxury segment, says Dominik Declercq. "Local carmakers have increasingly good products on offer at low prices, clearly also with export potential, but that does not yet apply to luxury models." Proof: while China's car exports increased last year, so, too, did imports - if only by 8 percent, to 160,000. But that figure can do naught but climb when China keeps its WTO commitment and by the end of this year cancels import duties on cars. Already, local production is no precondition for local sales, says Declercq. Porsche, he points out, is doing good business importing its luxury models.

It will take time before China has a luxury car to match anything foreign marques like Porsche. "China is a long way behind Japan, and look how long it took Toyota to come up with the Lexus and how much time, again, it took to establish the Lexus as a luxury brand," says Declercq. "Acquiring technological know-how is only the first step; creating brand awareness is another step, and prob-ably the more difficult one."

Less means more

More pressing for foreign carmakers in China is looming pro-duction overcapacity dragging down prices and eroding prof-itability. Oversupply and fierce competition were among the reasons for the NDRC to suggest that the government should encourage development of more energy-efficient (read: more high-tech) cars.

But overcapacity in the long run is debatable, says Declercq. If sales growth projections of 15 percent per annum for the next decade hold true, overcapacity today could mean a lack of pro-duction capacity a few years from now. "Individual manufactur-ers are still investing in new capacity and therefore would not identify overcapacity as a problem - at least not for themselves," he says.

Better then for China to allow the market to weed out the weak-lings making dodgy cars that no one wants. There are several ways to do that, says Declercq. Financing is often too easy to obtain. "Favouritism shown by officials to local car companies can ex-tend to arranging financing for new capacity not always based on proper business projections. Companies that ought to go bank-rupt, don't." There are over 200 vehicle producers in China but foreign makers, limited to investing 50 percent of their capital in a maximum of two joint ventures, cannot easily buy up or merge with local firms. Hence, if market demand holds up, there won't be a problem, but there is a "systemic risk" of overcapacity, says Declercq.

At its Hangzhou headquarters, meanwhile, a new Geely R&D office is coming up with ideas for car shows around China - and the world. Geely promises to offer low-emission compact cars at a value price. The competition has plans, too: the 2.0-litre Citroen C-Triomphe hitting the streets in May will sell at the top range for RMB220,000. PSA Peugeot Citroen-Dongfeng hopes to sell 50,000 units this year. Chrysler, meanwhile, hopes to build on sales of more than 1,000 of the 2005 edition of its Grand Voyager in China last year. Imports of the mini passenger van, which retails in Beijing for RMB398,000, will double this year, its makers hope. Geely's boxy 1.3-litre sedan is ugly by comparison but is selling fast for RMB80,000 in most Chinese showrooms. Proof, then, that in China bigger isn't always better, but there's still room enough for everyone.